Thursday, March 29, 2007

I attended the new Venture Fair at the Himss Conference (The major Healthcare Information Technology Association) and applaud the organizers for launching this new event. In spite of its maiden voyage, it was very well organized, well attended and very effective. In fact, the biggest difficulty was the weather not co-operating and the morning session had a majority of entrepreneurial presenters compared with qualified investors. By Mid Afternoon, with late arrivals, however, the ratio of investor to presenter was approximately one-to-one.

I am looking forward to attending this event at next year's conference and anticipate that the word will get out and attendance will triple.

If there were a disappointment, it was that only Eclipsys had a representative attending and all of the other major HIT vendors were absent. Part of that may have been because this was a brand new event. At the very least, the big guys should want to keep their finger on the pulse of the up and coming technologies. Some useful platforms were presented including a patient smart card, biometric security and a voluntary patient reported health record.

In spite of the passion and creativity of this group of entrepreneurs, half of them will not be around in two years. The major hospitals are not early adapters. The implementation of new technology can often be way more costly and difficult than originally anticipated and results are not guaranteed. Combine that technology risk with the "small company risk" and the sales environment is not very welcoming.

Like the entrepreneurs in the room, I too want to have a positive impact on the healthcare system, but our firm is a little investment-banking firm. So I am going to apply my passion and creativity to propose a new financial paradigm that is designed to accelerate the introduction of game changing technologies. I call this our Hybrid M&A Model. It is designed to provide the entrepreneur the capital to develop his or her technology toward commercial success. This new model invites the big HIT players in as venture investors.

They would acquire a minority equity interest in promising companies with a call option exercisable at some future date at a predetermined, contractually negotiated valuation metric. Now for the hard part. They then take the role as a supporter of their investment and tell the entrepreneur to press on as an entrepreneur. The spirit, passion, and energy of the entrepreneur remain in tact. More importantly, the efficiency of the start-up remains in tact. Translation – very low overhead compared to a comparable product launch with a large company's infrastructure.

The advantages to the large company are that they create a very low cost and efficient R&D platform. They dramatically reduce their financial risk of major product development failures. They also spread their risk over a portfolio of promising technologies. If they do exercise their call option, they have actually helped the seller make his/her company more expensive. However, it is likely that their pre-negotiated valuation metric will allow them to complete the acquisition at below current market value.

The entrepreneur is able to secure much needed funding to help develop his/her vision. More importantly, however, is the backing of the major HIT vendor largely removes the "small company risk" component for the risk adverse hospital decision makers. This alone will accelerate the adoption of new technologies so they can reach the scale necessary for commercial success.Some very smart and successful companies like Cisco Systems have deployed similar models with great success. They recognize they do not have a monopoly on all the great new developments in their industry so they cast their net over a broad territory through this type of creative equity investment

Wednesday, March 28, 2007

If you are an entrepreneur with a small technology based company looking to take it to the next level, this article should be of particular interest to you. Your natural inclination may be to seek venture capital or private equity to fund your growth. According to Jim Casparie, founder and CEO of the Venture Alliance, the odds of getting Venture funding remain below 3%. Given those odds, the six to nine month process, the heavy, often punishing valuations, the expense of the process, this might not be the best path for you to take. We have created a hybrid M&A model designed to bring the appropriate capital resources to you entrepreneurs. It allows the entrepreneur to bring in smart money and to maintain control. We have taken the experiences of several technology entrepreneurs and combined that with our traditional investment banker Merger and Acquisition approach and crafted a model that both large industry players and the high tech business owners are embracing.

Our experiences in the technology space led us to the conclusion that new product introductions were most efficiently and cost effectively the purview of the smaller, nimble, low overhead companies and not the technology giants. Most of the recent blockbuster products have been the result of an entrepreneurial effort from an early stage company bootstrapping its growth in a very cost conscious lean environment. The big companies, with all their seeming advantages experienced a high failure rate in new product introductions and the losses resulting from this art of capturing the next hot technology were substantial. Don’t get us wrong. There were hundreds of failures from the start-ups as well. However, the failure for the edgy little start-up resulted in losses in the $1 - $5 million range. The same result from an industry giant was often in the $100 million to $250 million range.

For every Google, Ebay, or Salesforce.com, there are literally hundreds of companies that either flame out or never reach a critical mass beyond a loyal early adapter market. It seems like the mentality of these smaller business owners is, using the example of the popular TV show, Deal or No Deal, to hold out for the $1 million briefcase. What about that logical contestant that objectively weighs the facts and the odds and cashes out for $280,000?

As we discussed the dynamics of this market, we were drawn to a merger and acquisition model commonly used by technology bell weather, Cisco Systems, that we felt could also be applied to a broad cross section of companies in the high tech niche. Cisco Systems is a serial acquirer of companies. They do a tremendous amount of R&D and organic product development. They recognize, however, that they cannot possibly capture all the new developments in this rapidly changing field through internal development alone.

Cisco seeks out investments in promising, small, technology companies and this approach has been a key element in their market dominance. They bring what we refer to as smart money to the high tech entrepreneur. They purchase a minority stake in the early stage company with a call option on acquiring the remainder at a later date with an agreed-upon valuation multiple. This structure is a brilliantly elegant method to dramatically enhance the risk reward profile of new product introduction. Here is why:

For the Entrepreneur: (Just substitute in your technology industry giant’s name that is in your category for Cisco below)

The involvement of Cisco – resources, market presence, brand, distribution capability is a self fulfilling prophecy to your product’s success.For the same level of dilution that an entrepreneur would get from a VC, angel investor or private equity group, the entrepreneur gets the performance leverage of “smart money.” See #1.The entrepreneur gets to grow his business with Cisco’s support at a far more rapid pace than he could alone. He is more likely to establish the critical mass needed for market leadership within his industry’s brief window of opportunity.He gets an exit strategy with an established valuation metric while the buyer helps him make his exit much more lucrative.As an old Wharton professor used to ask, “What would you rather have, all of a grape or part of a watermelon?” That sums it up pretty well. The involvement of Cisco gives the product a much better probability of growing significantly. The entrepreneur will own a meaningful portion of a far bigger asset.

For the Large Company Investor:

Create access to a large funnel of developing technology and products.Creates a very nimble, market sensitive, product development or R&D arm.Minor resource allocation to the autonomous operator during his “skunk works” market proving development stage.Diversify their product development portfolio – because this approach provides for a relatively small investment in a greater number of opportunities fueled by the entrepreneurial spirit, they greatly improve the probability of creating a winner.By investing early and getting an equity position in a small company and favorable valuation metrics on the call option, they pay a fraction of the market price to what they would have to pay if they acquired the company once the product had proven successful.

Let's use two hypothetical companies to demonstrate this model, Big Green Technologies, and Mobile CRM Systems. Big Green Technologies utilized this model successfully with their investment in Mobile CRM Systems. Big Green Technologies acquired a 25% equity stake in Mobile CRM Systems in 1999 for $4 million. While allowing this entrepreneurial firm to operate autonomously, they backed them with leverage and a modest level of capital resources. Sales exploded and Big Green Technologies exercised their call option on the remaining 75% equity in Mobile CRM Systems in 2004 for $224 million. Sales for Mobile CRM Systems were projected to hit $420 million in 2005.

Given today’s valuation metrics for a company with Mobile CRM Systems' growth rate and profitability, their market cap is about $1.26 Billion, or 3 times trailing 12 months revenue. Big Green Technologies invested $5 million initially, gave them access to their leverage, and exercised their call option for $224 million. Their effective acquisition price totaling $229 million represents an 82% discount to Mobile CRM Systems' 2005 market cap.

Big Green Technologies is reaping additional benefits. This acquisition was the catalyst for several additional investments in the mobile computing and content end of the tech industry. These acquisitions have transformed Big Green Technologies from a low growth legacy provider into a Wall Street standout with a growing stable of high margin, high growth brands.

Big Green Technologies' profits have tripled in four years and the stock price has doubled since 2000, far outpacing the tech industry average. This success has triggered the aggressive introduction of new products and new markets. Not bad for a $5 million bet on a new product in 1999. Wait, let’s not forget about our entrepreneur. His total proceeds of $229 million are a fantastic 5- year result for a little company with 1999 sales of under $20 million.

MidMarket Capital has borrowed this model combining the Cisco hybrid acquisition experience with our investment banking experience to offer this unique Investment Banking service. MMC can either represent the small entrepreneurial firm looking for the “smart money” investment with the appropriate growth partner or the large industry player looking to enhance their new product strategy with this creative approach. This model has successfully served the technology industry through periods of outstanding growth and market value creation. Many of the same dynamics are present today in the high tech industry and these same transaction strutctures can be similarly employed to create value.

MidMarket Capital, Inc., MMC is an M&A Advisory firm specializing in providing corporate finance and investment banking services to entrepreneurs and middle market corporate clients in the high tech, and select niche markets. The firm counsels clients in the areas of mergers, acquisitions and divestitures, private placements of debt and equity, valuations, corporate growth and turnarounds. Dave began Mergers and Acquisitions practice after a twenty-year career within the financial and information technology industries. Contact Dave Kauppi (630) 325-0123 http://www.midmarkcap.com/ davekauppi@midmarkcap.com

Saturday, March 10, 2007

I sit on the board of directors of the Midwest Business Brokers and Intermediaries (MBBI). An attorney from a small Chicago law firm was recently elected to the board. In his first meeting he introduced himself and said he was on the board at a Chicago attorney association. He stood up in front of our board and said, "You guys don't have a very good reputation in the legal community.

That certainly got our attention and he went on to explain the reasons why. As I listened to him, it occurred to me that what he was describing was the behaviors of a few of the big national Middle market M&A firms that put on the Business Seller Seminars. Because these firms have so much marketing muscle, they effectively become the face of our profession. No wonder the legal profession does not embrace us.

I walked up to him after the meeting and asked him if I could meet with him and share with him another view of our profession. As our meeting date approached, I was contacted by a business owner who had located me through a Google search (we write a lot of articles) and told me his sad story.

This was a small company that I would describe as being in the pre-profit stage. This owner had received a series of solicitations inviting him to come to a seminar about selling his business. He signed up and was contacted by phone several more times by this company's representatives to make sure he would attend. They were very specific that he should not bring any company logo items to the seminar for confidentiality reasons.

The presentations were very professionally orchestrated and this firm gave the attendees the impression that the M&A firm possessed this special skill to take these companies and write a powerful "Book" that would dramatically improve their value to the market. They actually used the words, "We will dress up the Pig." They also said they had a big roster of foreign buyers and that they had an upcoming conference in Brussels where they would be presenting the seminar attendees' companies to these qualified buyers that were just dying to get their hands on American companies.

In the Seminar's question and answer period, this business owner asked, "Why am I here?" The presenter jumped all over that one. Everyone of you in this room was specifically selected because your industry is hot with M&A activity. Later in the presentation, one of the seminar presenters took this owner aside and said he would give him a break on the $37,000 up front fees.

They scheduled a follow-up meeting where this Seminar guy pounded on this poor business owner and below is a cut and paste from the email this seller sent me:

"Thanks a lot for the high speed education this morning. The man explained that because of the vast target market for the Product Name Confidential globally, it's effectiveness and price etc. that Company Name Confidential in the right hands could generate $300,000,000 a year etc. blah blah blah. "It would also give the buyer enhanced stock value. We probably have about 200 qualified buyers right now for you..." He continues, "What you have is an oil well, what the buyer has is a derrick". He's from Texas thus, the oil analogy. "One owner no partners with all their attorneys this will be so easy to sell, so clean neat and tidy....."

Finally, "He left very angry because I told him I wasn't gonna pay them $29,000. So.. I was left to believe that $29,000 was gonna stop his firm from reaping all that "easy money". That just doesn't sound real world enough for me. I don't want to be stuck in their database. I don't know what he was pissed about... They called me I didn't call them. I'm not on any "I wanna sell my company" lists. Hell I just got the company phone number listed about two weeks ago. Honest to God I haven't gotten the first Company Name Confidential phone bill yet."

Wow. Where do I begin? How about what a sleazy, dishonest, outrageous load of bull.Luckily this seller had talked to me before his meeting and I warned him about this approach. I had no idea it was quite this misleading. This business owner sent this guy packing and he was ticked off because he didn't sell a $29,000 book.

As long as I have gone this far, I might as well expose the whole story. This approach works to sign up business owners with stars in their eyes for $37,000 books. What an awesome business. Write a book with industry boilerplate and some minor analysis compiled by some recent grad analysts sitting in a room at HQ that costs the seminar company a maximum of $2500 to produce. Enter these deals into their inventory database and send it out to the Private Equity Groups and present the list to the foreign buyers.

They lock up the seller with a long contract tail and effectively prevent a legitimate firm from actually working the sale process for 2 to 3 years. If the business is in the 2 in 10 that gets immediate interest, then the seminar firm will have a banker work on it. If you are in the unfortunate 8, you become a passive entry in their deal inventory.

Our bankers and the bankers of the 90% of M&A companies that provide a fair value for their services, can only handle effectively four to five simultaneous transactions. If you took this Seminar Company's deal inventory and divided it by the number of bankers, you would find that they have over 25 live deals per banker. It is impossible to professionally represent these sellers who have paid an up-front fee of $37,000 for this service.

Foreign buyers are not stupid, they do not pay more for companies than American companies, and they are generally not interested in even looking at an acquisition under $25 million in revenue. A "book" never sold a company or made it more valuable. Making changes in your company to improve its performance will make it more valuable. A good M&A advisor or your CPA can provide you important input about that.

What really helps you maximize your company's selling price is to have an M&A advisor directly contact the universe of most likely strategic buyers and to get several interested in your company. This results in a competition for your company, often called a soft auction. As these strategic buyers view your company as a must have acquisition, the price and terms are significantly improved.

For Business Owners Seeking Strategic Value in Their Company Sale

Have you ever marveled at the prices at which some companies sell while most others sell at predictable valuation metrics. Much of this value creation secret is the result of "STRATEGIC ASSETS". These are assets that do not appear on a company balance sheet, yet they are hugely valuable to strategic industry buyers. This checklist will help you identify, nurture, and develop key drivers of transaction value for your eventual business sale.